Green: Supersize Dread

MCDONALD'S FUTURE IS SMELLING WORSE THAN ITS RESTAURANTS

Any investor with a week or so of experience quickly learns that the language of Wall Street isn't like language elsewhere. "Hold" means "sell," and an executive "leaving to spend more time with family" is getting chased out of town like a Megan's Law parolee. But McDonald's CEO Jack Greenberg might have raised the art of obfuscation to a new high when he deemed "challenging" the fact that his company's chief ingredient is staggering around in crazy circles, having to be incinerated due to incurable infection.

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Here's why McDonald's most recent quarter smelled even worse than its restaurants, and why things will get worse before they get better. On January 24, the world's largest restaurateur announced earnings of $452 million--thirty-four cents a share. Investors expecting thirty-five cents wrung their hands a bit about the pressures the company faced. In fact, the estimate had already come down from forty-one cents in early 2000, so this was actually a bigger miss than the one reflected by the 7 percent hit its shares took. To me, though, the biggest story was lost amid the earnings numbers.

McDonald's is one of the best-run companies ever. It opens stores at viral speed (1,700 coming this year, after 1,606 in 2000) and runs them with Auschwitz-like efficiency. There are four Mickey D's within walking distance of Esquire's offices in New York. Although I've ceased being amazed, I'm still impressed that each is packed, all day, every day. It's one thing to sell grotesquely corpulent red-meat caloric orgies when there's no nearby alternative. McDonald's manages to do so even in the eating capital of the country, where it is not even particularly inexpensive compared with a couple dozen superior pizza, sandwich, and sushi places.

So I'm not going to argue that people shouldn't like what McDonald's sells. They do, no doubt about it. But for the first time in ten-plus years of rooting against this company that symbolizes everything I hate about the world, the numbers show reason to suspect McDonald's might finally face some barriers to growth.

In the fourth quarter of 2000, sales were $3.59 billion, a 6.4 percent rise from $3.37 billion a year ago. But compared with 2000's third-quarter revs of $3.75 billion, sales actually shrank. That's big, because a business adding stores so quickly ought to be able to grow revenue easily. After all, even if each store's sales stay flat, the addition of new stores ought to add up to a bigger total-sales number. Investors know that it's earnings, not revenues, that really matter. Happily, the picture's bleak there as well. Q4 profits were a mere $452 million, way down from Q3's $549 million and beneath even Q4 1999's $486 million.

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Customers have long recognized that McDonald's isn't like other fast-food companies. Whereas Burger King has been staggering under its fry fiasco for two years, McDonald's launches flop after flop, from the McDLT to the Arch Deluxe, without missing a beat. It's not just a perception difference; investors value MCD more generously than its peers. Even after the stock closed down sharply on its bad earnings day, investors paying almost 31 for a share faced a PE of 21. Compare with Wendy's (17) or Tricon (12)--owner of KFC, Pizza Hut, and Taco Bell--and you see just how deeply McD's investors believe in the formula. McDonald's price per dollar of sales is also higher by far--$2.81 versus $1.37 for the sector average.

The reason an investor pays more for company A's dollar of profit than he'd pay for the same dollar from company B is that he believes A will grow today's dollar faster than B will. And for years, he was right to expect McDonald's to grow earnings faster than its peers. But signs that the company's extraordinary growth may have finally peaked are starting to appear:

__ Mad cow disease is having a bottom-line impact. Fear of Creutzfeldt-Ja-kob disease, the human form of the ill-ness known as bovine spongiform encephalopathy in cows, is quickly spread-ing beyond Britain, and BSE-infected cows have shown up in France and Germany. In January, a suspected mad cow was discovered at Cremonini, the Italian meat proces-sor McDonald's uses. McD's reaction to the panic so far has been symbolic--the company posted signs in Europe notifying customers about McDonald's stringent mad-cow screening process. Ads in France and Italy stressed that the parts of the cow its beef comes from aren't the supposed mad parts. How reassuring. The effects are real--Euro-pean McD's sales slipped 10 percent in Q4, a catastrophe for a market that's supposed to be among the company's fastest growing. Greenberg has said that "continuing consumer-confidence issues about European beef" will affect the first quarter of this year. How delicious that the company's ticker shares initials with mad cow disease.

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» McDonald's second-biggest national market is Japan, whose 3,600 outlets trail only our own 13,000. After opening 340 Japanese McD's last year, the company is planning only 220 this year, citing a "significantly worse" retail environment there.

» Long known as a stable, reliable grower, McDonald's has all of a sudden become dependent on unpredictable currencies. The weak euro, for example, contributed to its dismal quarterly report. Since the company is looking to China and other developing markets to take up the slack, expect currency fluctuations to knock results around. McDonald's-type investors are not big risk takers; they prefer the same sort of cookie-cutter predictability they get from a McDonald's menu. When factoring in the yen, yuan, and euro becomes part of the experience, the company's risk profile changes.

» Virtually all of McDonald's growth during the past ten years has come from abroad. McDonald's performance in the U. S. has been flat, but the company is responding to overseas-growth difficulties by trying to restake its greatness here at home. This year marks the debut of a major push to double domestic sales. To me, that plan smacks of acknowledging how tough the overseas market will continue to be.

MCDONALD'S WHOLE SECRET--and the reason investors will pay more for a dollar of McD's sales than Wendy's or BK's sales--is that it's been able to replicate its formula better than its peers and run it with mechanized precision. But that also makes it harder for McD's to adjust to new market realities, such as costlier beef and people who favor salads. If one believes that mad cows are indeed a long-term problem--and I definitely do--then one has to see McDonald's as particularly vulnerable. Why? Because of its cost structure and its reliance on a smooth-running system for its multiple. Put simply, if each pound of beef costs the consumer another $1 to feed, then I pay $20.50 instead of $20 for a half-pound steak at a fancy Parisian restaurant--the added 2.5 percent is immaterial. But if it changes the cost of a Double Quarter Pounder from $5 to $5.50, that's a 10 percent increase.

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Burgers are already not a profitable item for McDonald's--they break even on them at best. Let me share with you the insight that got me into the financial-writing game as a kid. When I was fifteen, I worked at Baskin-Robbins. I still ate meat then, and every night I got a delicious Quarter Pounder with cheese from the McD's next door for free in exchange for ice cream. The manager there was going to business school and, like all McD's managers, had graduated from Hamburger University. One night, he showed me a memo from HQ about how they were supposed to upsell fries and Cokes. (This was before "Supersize" had entered the vernacular.) "Ken, you know what McDonald's is? It's a gigantic Coca-Cola store," he said. "Everything else, from Ronald McDonald to Happy Meals, is to get you here to pay a buck for something that costs us five cents." Passing the higher cost of beef along to its customers could be devastating to McDonald's ability to do what it really is in business to do--sell you fries and Cokes.

My cards are on the table here. No company disgusts me more than McDonald's. The junk they sell has contributed to the one-in-five obesity rate among Americans and the 40 percent rise in diabetes since 1990. They lurk behind the slaughter of more animals than anyone else, the uglification of the planet, and the systematic lowering of standards throughout the world. Do I expect the people running the company to see the light and lay down their bloody arms? No. McDonald's is not a shorting candidate. It's too stable and its cash flow is too massive for a major catastrophe. But I do think that for the first time in the decade I've been following the company, it shows signs of real weakness, and I can't imagine how anyone can still justify paying a premium for its stock.

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If I Designed the Money... In 1984, I started work at the great poster and design company Hatch Show Print, in Nashville, Tennessee. I made $5 an hour that first day, and I went out and bought five hamburgers. Since then, I've had the chance to live in the Netherlands, Norway, and Italy. In all these places, I was amazed by the wildly colorful currencies honoring poets, musicians, and great thinkers. So I would put Hank Williams on the next American $5 bill, because he was a little bit of all of those. The $20 bill would have Bob Wills, Emmylou Harris would be on the $10 bill, and the $3 bill--yes, three dollars--would honor Johnny Cash. --Jim Sherraden, Hatch Show Print

Owe Taxes? Good News

HOW TO TAKE SOME PAIN OUT OF FUNDING LARDED PROGRAMS LIKE SCHOOL LUNCHES:

For the first time,you can pay your federal tax balance over the Internet with a credit card. But don't let free-mile perks cloud your vision. The typical rebate card offers one mile per dollar charged--if Uncle Sugar's needing ten large, you get ten thousand miles. Naturally, there's no free lunch here; the government makes you go through a "service provider," who'll charge you from 2.5 to 3 percent. That's at least $250 on a $10,000 payment. Considering that the miles are worth, at most, two cents apiece, that's a bum deal--don't spend $250 for $200, no matter how convenient.

Many of those who pay via credit card do so not for the miles but because they don't have the bread. Better idea: Take a home-equity loan. The rate is almost always lower than a credit card and the interest is tax-deductible.

Those whose brokeness is short-term might even consider loaning themselves the money. Withdrawals from IRAs are penalty-free if paid back within sixty days, and you can usually borrow from your 401(k), where you pay the interest back to yourself. Both options have pitfalls: Missing the sixty-day IRA payback is harsh (taxes plus penalties), and losing a job triggers immediate 401(k) payback requirements. But it's your money--don't be afraid to use it. --K. K.

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Mad-Panic Plays

LOOKING FOR A WAY TO PLAY MAD-COW MANIA?

A FEW IDEAS:

Recognize the power of McDonald's. Fresh-pork-belly futures soared to an eight-month high on the day McD's announced it would add more bacon items to the menu. If McDonald's continues to diversify its menus, look for sellers of chicken, turkey, and even exotica to benefit.

Cows unable to be fed other, ground-up cows (which presumably started this whole mess) will need a new source of cheap protein. Companies in the U. S. that stand to benefit include, ironically, those like Monsanto--which dominates the soybean trade here and abroad--who are possibly even bigger bastards than McDonald's. Life sucks.

Supermarkets and meat brokers around the world will face increased scrutiny. In France, thirty-nine stores in the Carrefour supermarket chain cleared all the meat off their shelves and recalled a bunch more after it came out that Carrefour had bought meat from cows in the same herd as a suspected mad one.

The Book

I don't trade these stocks, but each month I've been looking at a different company and giving it an analyst-style rating, then making upgrades or downgrades over time. KEY TO RATINGS: 1=Must buy; 2=Like, don't love; 3=Either neutral or deeply ambiguous; 4=Avoid; 5=Imminent doom--consider a short sale; _=Upgrade. Reach me at greenzine@aol.com.

After Amazon's massive Q4 loss, much of the bad news I wrote about four months ago is finally out in the open. That's the main reason I'm upgrading the stock (second upgrade in two months)--it's time for the pendulum to swing back to reasonable business principles and expectations. To wit, Amazon has decided to cut a meaningful number of jobs and pare unprofitable product lines. It's talking about operational profitability (not the real kind, but still) by year's end, and I'm starting to believe that's possible. Maytag's made a nice little move to the upside, and Juniper continues to falter.

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